Trapping 29 desperate miners on November 19, a devastating explosion at one of Pike River’s coal mines struck the quiet and isolated west coast of New Zealand’s south island by surprise. Many reminisced upon the miraculous recovery of the 33 Chilean miners in early October after being trapped in the damp copper mines of Chile for over two months. Alas, the world seems to have run out of miracles. A second explosion on November 24 finally verified the grim conclusions of the 29 missing men.

Pike River is New Zealand’s only listed coal company, one that specializes in high-quality coking coal that is shipped to Asia for additional processing in the manufacturing of steel. Coal mining safety standards have once again come under close scrutiny by the world’s eyes as recent accidents have prompted increased attention on the dangers of mining. It seems as though many of the world’s mines have skimmed away safety standards while struggling to meet the stringent demands for commodities like coal in the reawakening of demand from emerging-market economies like China and India. Aside from mining security, though, the implications of demand for coal in China and the rest of its emerging market peers are more far-reaching than ever before. As the world becomes increasingly globalized, the middle kingdom of China only continues to show itself as the center of a growing global trade network, especially in the case of internationally traded commodities such as coal.

Resurgence in Demand for Coal in Emerging Markets

Nearly two months ago on October 19, India engaged in its biggest initial public offering to date for Coal India, the world’s largest coal producer with mines that extracted over 430 million tonnes in 2009. Evidently, with India’s economy constantly accelerating, the country continues to run short on cheap energy, with analysts expecting the country to rely on coal-based energy for the next several decades. However, India’s poor transportation infrastructure network continues to be a hindrance to the country in its struggle to meet hungry power station demands for mountains of carbon. Such a poor system that already struggles to deliver the half a billion tonnes of coal the country consumes each year has forced the country to look beyond its borders for foreign coal mine acquisition opportunities, all while increasing international coal imports at the same time.

The World Bank estimates that 40% of Indian homes are still without electricity; it is because of this that India views coal as a necessary tool of poverty alleviation as it strives to brighten the lives of an entire nation. India, however, is not the only culprit in the recent scramble for coal deposits; with both the Asian tigers of South Korea and Taiwan also playing integral roles in global coal consumption, an upward pressure on coal demand, and consequently coal prices, is likely to continue in the near future.

images

As it can be seen, China is poised to overtake Japan as the world’s largest coal importer within the next year. With the latest Chinese capital pursuit of Australian coal mining firm Caledon Resources by a provincial Chinese sovereign wealth fund for US $407 million, the current Chinese appetite for coal shows no signs of relenting. Premier Wen Jiabao was quoted earlier this year saying that “easing demand and supply strains on coal is crucial to making adjustments to the operation of the economy.”

Evidently, Beijing has become increasingly inclined to rely more heavily on imports while conserving domestic coal reserves, a trend which is odd considering China holds the third place for largest national reserves of coal in the world, right behind the US and Russia. All of this then can be explained by analyzing China’s change from a net exporter to a net importer of coal between 2008 and 2009.

The “China Moment”

Many commodities analysts often say a "China moment” happens when the world’s most populous country shifts from being an exporter to a net importer of a certain resource. In general, as Chinese internal demand overextends the capabilities of domestic production, Chinese imports inevitably begin to increase, and global prices tend to rise as a consequence. This has happened in the past with oil and other commodities like soybeans, and now, it is happening with coal.

The subtle difference this time, however, is that Chinese domestic output is fully capable of satisfying internal demand.

Producing nearly 2.96 billion tonnes of coal in 2009, with a staggering 114.5 billion tonnes in reserves, many analysts have sought insight on the unusual spike in Chinese demand for imported coal.

Coal Arbitrage in China

To understand this unusual phenomenon, one must review the geographic fundamentals of the Chinese coal market. Many of China’s coal resources are concentrated in the northwestern parts of the nation. Coal demanded from the northern coastal areas is served through a series of intricate truck routes and railways that move coal east and south from the west and north. Southeast China, however, is a different story, as rail and truck fees are relatively expensive for such a distance. Instead, coal is first transported via rail to eastern ports, and then shipped via sea routes to the southeast.

Coal transported from the north to a province in the southeast like Guangzhou can sometimes cost as much as 50-60% of the price of the coal delivered. Such a dramatic price increase opens a window of opportunity for imports to compete with domestic output. Especially in the case of southeastern China, a gateway to Indonesian and Australian imports, the arbitrage opportunity presents a situation for local Chinese buyers to take advantage of such price differences. In 2009, this price difference finally began to favor imports.

During and after the financial crisis, the historical relationship of domestic and international coal consumption in China inverted itself. Indonesian coal was as much as US $40/ton more profitable to purchase than domestic coal, with Australian and Russian coal following the same trend. Consequently, imports began to skyrocket, and peaked in the winter of 2009 to 2010. Being a cost minimizer, China will import when discrepancies between domestic and international coal dictate it to do so, and such a situation was evidently present.

Causes of the Arbitrage Inversion

The global financial crisis did not impact China as heavily as it did a lot of the other coal consuming nations. China’s GDP growth was 9.6% in 2008 and 9.1% in 2009, demonstrating only a 0.5% decrease during the toughest times of the recession. In contrast, global GDP growth was negative 2.1% in 2009, so it can be said that China’s macroeconomic activity sustained relatively high levels of demand for energy in comparison to other coal importing economies – and energy demand translates to coal imports in the case of China.

As a result of the financial crisis, international freight prices for coal dropped significantly below domestic freight prices, which further spurred buyers to gravitate towards extending their grasp on imports. In addition to the advantages imports already had, the government began a campaign of coal mine consolidation, closing small, inefficient rural mines that were not as technologically adept as other large firms. This temporarily lowered supplies and placed upward pressure on domestic prices, further closing the deal for increased imports of coal. In addition, Chinese national policy further facilitated the import increases, emphasizing “walking out” of the country to explore international market opportunities so long as the economics justified it, and in early 2009, they had.

Looking Forward in the Eyes of the Dragon

Once having an isolated coal market, China now plays an integral role in global trade flows and prices with its ever expanding economy, especially when it comes to commodities like coal. China now accounts for nearly 15% of globally traded coal, demonstrating its position as a leader in global coal consumption, only to be rivaled by the likes of South Korea and India. Indian demand for coal, however, is inherently different than Chinese demand, due to its shortage of domestic supplies in meeting internal energy demands.

China, on the other hand, has the choice between purchasing its share of coal internationally and consuming its own domestic output, with the final choice depending on the favorability of international or domestic prices of coal. Due to China’s relatively large share of global coal consumption, international coal prices will only become increasingly linked to China’s own domestic prices as domestic and global prices inch closer towards parity.

Ultimately, what happens in a coal-producing province like Shanxi will have an increasingly pronounced effect on coal prices across the world.